ECRI explains the global slowdown, and what lies ahead

Summary: The Economic Cycle Research Institute (ECRI), who correctly predicted the slow recovery, looks at the multi-year slowing in the economies of the developed nations — its causes (the world is becoming Japan) and likely consequences.

ECRI, 20 June 2016.
Reposted with their generous permission.

The risk of a global recession is edging up, as the global slowdown we first noted last fall continues (ICO Essentials, September 2015). This danger is heightened because longer-term trend growth is slowing in every Group of Seven (G7) economy, as dictated by simple math: growth in output per hour, i.e., labor productivity – plus growth in the potential labor force – a proxy for hours worked – adding up to real GDP growth.

As we laid out over a year ago (USCO Essentials, June 2015), this simple combination of productivity and demographic trends reveals that U.S. trend GDP growth is converging toward 1%. This is reminiscent of Japan during its “lost decades,” where average annual real GDP growth registered just ¾%, which is why we have cautioned that the U.S. is “becoming Japan” (USCO Essentials, February 2016) and (ICO, July 2013).

Expanding this analysis to the rest of the G7, we find that every economy is effectively becoming Japan, and the sharpest slowdowns are happening outside North America. Thus, as trend growth falls in the world’s largest advanced economies amid the ongoing global slowdown, the threat of a global recession is growing.

In the face of slowing U.S. trend growth, the Fed had hoped that the U.S. economy would recover to earlier levels of trend growth, provided they could find the right size and mix of quantitative easing and low interest rate policies. We dubbed this effort, a “Grand Experiment,” which has served only to pull demand forward, ultimately depleting future demand and failing to achieve the Fed’s objective. Other G7 central banks have arguably made even greater attempts at ginning up growth, but with even less to show for it.

To make our simple math analysis consistent internationally, we used comparable annual data for productivity, labor force, and potential labor force for each G7 country. Then, we examined the data for the half-century preceding the Global Financial Crisis (GFC). Separately, we examined labor productivity growth in the 2010-15 period and potential labor force growth in the 2015-20 period to estimate trend growth in the latter period. As productivity is notoriously difficult to predict, and there is no compelling reason to expect it to change significantly in the near term, we used the last five years’ average productivity growth as the best available estimate for the next few years. The results for the U.S. were quite consistent with our original findings.

Outside of North America, trend growth will likely be even worse. Indeed, the German outlook is substantially weaker than that of the major developed English-speaking economies. While average productivity growth was relatively high at 0.8% from 2010-15, as shown in the chart (upper panel, red line), with negative 0.4% annualized potential labor force growth for 2015-20 (lower panel, red line), trend GDP growth is expected to be only 0.4% over the second half of this decade. To what extent Brexit will change the growth trajectory remains to be seen, but it is unlikely to help.

In Germany productivity growth averaged nearly 4% a year in the 1957-2007 period – being a bit higher in the 1960s and a little lower in the 1990s (upper panel, gold line), while labor force growth was reasonably steady around 0.3% (lower panel, gold line). Thus, the growth rates of both productivity and the labor force have downshifted substantially in Germany in recent years – a major problem, since Germany is the Eurozone’s growth locomotive.

Still, no G7 economy has as dire an outlook as Japan, where trend GDP growth is converging to zero over the next five years. Indeed, with the potential labor force set to average -0.4% annual growth and productivity growth having averaged 0.4% for 2010-15 (not shown), they effectively offset each other, netting zero trend GDP growth. Unlike the rest of the G7, Japan has annualized growth stair-stepping down for both productivity and the labor force.

Conclusions

All of this highlights the degree to which the G7 economies are “becoming Japan.” In the 1957-2007 period, all of the economies except Japan were in the three-to–four-percent trend growth range. But, in the 2015-20 period, while Japan is on a zero-percent trend growth trajectory, Germany is on track for just 0.4% trend GDP growth. As productivity and labor force growth slow, all of the G7 economies are converging to lower levels of trend growth, with Japan leading the race to zero.

Of course, this lower trend growth problem is a hallmark of our “yo-yo years” thesis (ICO, March 2012), which posits that lower trend growth and higher cycle volatility lead to more frequent recessions. This is because, when trend growth is close to zero, it is relatively easy during growth rate cycle (GRC) downturns for actual growth to fall below zero for a sustained period, triggering a business cycle recession.

Another result of lower trend growth has been competitive devaluation (ICO Essentials, March 2015). As domestic demand fails to deliver sufficient growth, countries attempt to stoke growth through exports by devaluing their currency. However, as export volume growth hovers around zero for advanced economies and export price growth is negative, these countries are fighting over a shrinking trade pie (ICO Essentials, April 2016).

At the moment, all of the G7 economies are either in, or on the cusp of, GRC downturns, and therefore recession remains on the table, to some extent, in all cases. Given the ongoing global slowdown, this means that a global recession, while not at hand, is a distinct possibility in the relative near term. This is precisely the situation where the global economy can ill-afford major negative shocks, especially if some of these G7 economies enter windows of cyclical vulnerability defined by pronounced, pervasive and persistent downturns in the levels of their respective long leading indexes. With central banks around the world essentially out of ammunition and unable to reach any consensus on how to get growth back on track, a global recession would be particularly problematic.

———————— End of ECRI report ————————

About the Economic Cycle Research Institute

The ECRI is an independent research institute. Their indicator systems predict the timing of changes in an economy’s direction, before the consensus of economists. It is one of the three best-known non-government publishers of leading indicators, along with the Conference Board and the OECD.

The ECRI’s co-founder was Geoffrey H. Moore. From his March 2000 NY Times obituary ”In a sense, he was the father of the leading indicators as we know them today,” said Anirvan Banerji, co-director of research with Dr. Moore at the ECRI. The successor to the forecasting tools he developed is ECRI’s Weekly Leading Index (WLI). From 1949 to 1978 Moore set the start and end dates of recessions for the National Bureau of Economic Research (NBER). When they created a committee for this, he was its senior member. Using the same approach, ECRI has long determined recession start and end dates for 20 other countries that are widely accepted by academics and major central banks as the definitive international business cycle chronologies.

The GDP sensitivity varies from nation to nation (Norway is a big exporter; Japan is a big importer), and has decreased over time. Plus the money spent on oil imports is not burned. It goes to oil exporting nations that in turn use some of it to buy goods and services from the G7. So there is no clear basis for calculating the net effect of oil prices on G-7 economies.

But is that an important question? It’s not clear that the global economy has any significant sensitivity to oil prices. That is, the effect is mostly on distribution of growth.

There was a larger effect in the past, when GDP was more sensitive to GDP and many oil importers saved their income (savings depresses GDP). Few oil exporters will be saving much until oil prices are over $80 (the fiscal breakeven for the Saudi Princes is roughly $95).

What’s clear is that if oil prices don’t rise above $70 – $90 (we don’t know the number), the world will have yet another boom-bust cycle of oil prices. Low prices will depress oil industry capex — while demand rises (boosted by low prices) and existing fields deplete. Eventually a supply deficit will appear (like 2007-08), pushing prices up to both boost capex and destroy the excess demand). This is not good for either the oil industry or the world economy. These cycles are also a source of geopolitical instability.

“But is that an important question? It’s not clear that the global economy has any significant sensitivity to oil prices. That is, the effect is mostly on distribution of growth.”

Interesting, I always assumed that overall global economic growth must be sensitive to oil prices. I mean a swing in oil prices from say $50 to $100/barrel is somewhere around $1.6 trillion USD per year or so? It just seems that even though trade balances between oil importers and exporters might balance out that a disproportionate amount of cost will end up being footed by the average oil consumer. For them an oil spike could easily be a few percent increase in yearly expenditures and in many cases they are too indebted to adjust patterns.

“What’s clear is that if oil prices don’t rise above $70 – $90 (we don’t know the number), the world will have yet another boom-bust cycle of oil prices. Low prices will depress oil industry capex — while demand rises (boosted by low prices) and existing fields deplete. Eventually a supply deficit will appear (like 2007-08), pushing prices up to both boost capex and destroy the excess demand). This is not good for either the oil industry or the world economy. These cycles are also a source of geopolitical instability.

It’s a common mistake, because the lurid economic “analysis” that dominate websites is so interesting because it usually looks at only one side of the equation. What is done with that oil consumer’s money matters just as much.

“Such a cycle seems pretty inevitable at this point with the shale industry in shambles. ”

The US oil industry gets disproportionate attention because its here, and to us we’re the world. Much as nat gas prices vary depending on the weather in Manhattan. The effect of low oil prices is felt around the world, most especially in the areas with the highest cost of production. Alberta, Brazil (the deep offshore fields which were to be its salvation are now worthless), etc.

“In the face of slowing U.S. trend growth, the Fed had hoped that the U.S. economy would recover to earlier levels of trend growth, provided they could find the right size and mix of quantitative easing and low interest rate policies.”

This quote, along with the report as a whole, raises the following question: Why the fixation on growth? Indeed, history tells us that too much growth can lead to disaster. Just before the Revolutionary War, for example, the British Empire won vast amounts of territory from France as a result of the Seven Years’ War. In order to maintain their distended empire, the British sought to increase revenue at the expense of the colonists through the Sugar Act, the Colonial Currency Act, the Stamp Act … the list goes on.

In short, the power-hungry Brits took on more than they could chew, and they tried to solve the problem fiscally. Now, the United States maintains hundreds of bases throughout the globe and it continues to prosecute a nearly 15-year-old war in Afghanistan. If we shut down bases and end the war, perhaps we will not be so fixated on increasing our “gross” domestic product.

“This quote, along with the report as a whole, raises the following question: Why the fixation on growth? ”

Have you missed many meals lately due to poverty? Been unable to send your child to college due to lack of funds?

“As any oncologist will tell you, not all growth is benign.”

You are conflating two very different questions, the usual “economists are stupid” analysis. Everybody with an above room-temp IQ knows this. But your examples of pathalogical growth have zero zip nada relevance to that of America’s current slow growth.

“The United States maintains hundreds of bases throughout the globe”

US military spending is less than 4% of US GDP. Slashing it by half would have little effect on the US economy, adding the equivalent of one year’s growth to some other form of spending.

“If we shut down bases and end the war, perhaps we will not be so fixated on increasing our “gross” domestic product.”

“But your examples of pathalogical [sic] growth have zero zip nada relevance to that of America’s current slow growth.”

This is why I used the analogy of the British Empire. To be more specific, the British tried to maintain an overseas empire which had expanded after major conflicts with other European powers. The end result was debt and an overtaxed population that revolted, with serious consequences for the Empire. My main point was that the British Empire, in the long run, collapsed under its own weight not because its rate of growth was too slow, but because it was too fast.

“US military spending is less than 4% of US GDP. Slashing it by half would have little effect on the US economy, adding the equivalent of one year’s growth to some other form of spending.”

By some estimates, the war in Afghanistan has cost us nearly one trillion dollars (see http://www.ft.com/cms/s/2/14be0e0c-8255-11e4-ace7-00144feabdc0.html#slide0). This amount alone (i.e., excluding costs of maintaining hundreds of military bases throughout the globe, and excluding the costs of other military conflicts, including Iraq) would have a significant impact on our capacity to feed the hungry and send children to college, to use your examples.

Correct me if I’m wrong, but the namesake of this blog saved Rome by undertaking a defensive posture. This is the opposite of what the British had done during the Seven Years’ War, and it’s the opposite of what the United States is doing now.

In short, I agree with you, poverty and lack of education are serious problems in this country. But continuing to increase our GDP will not solve our problems if our government’s fiscal and military policies are hampered by fear, greed, and ignorance.

For the record, I never said that “economists are stupid.” If I implied that in my post, I apologize. Regardless, please make a note if you make any changes to my post (my original post was one paragraph).

“The end result was debt and an overtaxed population that revolted, with serious consequences for the Empire.”

The US is not overtaxed in any meaningful sense. Certainly taxes are not causing any economic distress. The US grew faster when taxes where higher in the post-WWII era.

“My main point was that the British Empire, in the long run, collapsed under its own weight not because its rate of growth was too slow, but because it was too fast.”

Can you cite a historian or economist who agrees with you? I doubt it.

The British empire collapsed for the same reason the German, Russian, Austro-Hungarian, and Ottoman Empires collapsed — internal social change and collapse of the long peace into WWI (1815-1914). The final straw for Britain was the development of 4GW methods, by which local insurgents could defeat foreign armies.

The prospect of “turning Japanese” has never seemed less appealing. Sorry, Vapors.

But I wonder about that dropping labor productivity. Shouldn’t the robot revolution be doing something to keep it up? I thought these machines were replacing us because they were more productive than we are.

The failure of new tech to increase productivity — either labor productivity or multifactor productivity — is one of the great mysteries of economics. Perhaps the robot revolution — now just starting — will change this.

Ah, there’s my mistake. I see the robots filling more and more jobs and I ask why they haven’t completely changed the world yet, and the answer is that I need to learn patience because these things take time.

This also describes my attitude towards the coming intelligence explosion. I hear the AI theorists talk about AI surpassing human intelligence at some point within the next century, and my next thought is “What’s talking you guys so long?” Master Yoda would be so disappointed in me…

“I see the robots filling more and more jobs and I ask why they haven’t completely changed the world yet, and the answer is that I need to learn patience because these things take time.”

Robots have filled very few jobs (I think you’re watching too much TV). The use of new tech during the past two decades has involved simple automation. The coming revolution of smart machines will offer greater opportunities for social change.

“This article addresses the implications of the cost of warfare and the debt burdens that typically arise from conflicts. It examines how much Britain’s public debt rose during and after the Seven Years’ War and the implications of this growth. While it considers the various reasons for the dramatic rise, the primary focus is military spending. The addition of the North American continent as a major theater of war created the need for higher spending and helped double the national debt from the pre-war total. As with modern economic issues, contemporary discussion of the debt crisis became a normal talking point in letters and political debates. Ultimately, this article supports the argument that the Seven Years’ War contributed to the American Revolution via the unexpected fiscal pressures on Great Britain”

I’m not saying that the Seven Years’ War serves as a perfect analogy to our current situation. Moreover, if I implied that the entire British Empire collapsed due to its territorial conquests in North America, I stated my case wrongly. Regardless, my main point still stands: the sudden growth of the Empire became a financial and military burden that resulted in a lost war and a major setback for the British. As far as the late 18th-century British Empire is concerned, the problem as I see it was not slow or stagnant GDP, but an unmanageable Empire distended by an aggressive military policy. Looking at the big picture, U.S. real GDP per capita has increased tremendously since WWII. Nonetheless we still face problems with poverty and education, to use your examples. I don’t see how increasing GDP growth will help solve these problems so long as the allocation of our resources is mismanaged.

Finally, your reference to World War I only serves to undermine the confidence I have in the ECRI report. One of the main flaws of this report is the assumption that “there is no compelling reason to expect [productivity] to change significantly in the near term.” World War I (along with its dramatic effects on the economies of the belligerent powers) was not a prediction that could be made even in the years leading up to the war. Similarly, the political and economic effects of the war in Afghanistan and the continuing conflicts in Iraq and Syria (not to mention possible future conflicts, whether in the near term or long term) remain far from being predictable. This is another reason why we should be very skeptical of ECRI’s “simple math.”

“Your theory is that the British Empire fell because it “grew too fast”. That’s absurd. Hence I asked for a supporting cite.”

I’ll concede the point as you’ve stated it here, though I’m not convinced that the “theory” (really, a claim) is absurd. In any case, as I explained in my previous post, my argument does not hinge on this “theory” and you’ve failed to address the points that I’ve made in my previous post, other than saying that my comparison is “nothing new.” The purpose of the comparison is to argue against some of the key assumptions made in the ECRI report using the British Empire as an analogy. To claim that the comparison is nothing new is simply a red herring. I could easily argue that the comparison of the United States with Japan is nothing new, either, but that’s besides the point.

“I’m not saying that the Seven Years’ War serves as a perfect analogy to our current situation.”

The analogy you draw between the debt incurred in the 1756-63 war and US current debt is absurd. The greatest growth of the British Empire was in the 150 years after the Seven Years War. There is zero evidence that it was problematic for them in any long-term sense.

Yes, imposing taxes on the N. Am colonies caused stress. But the colonies were certain to be taxed in some fashion, even if there had not been a 7 Years War. After all, resource extraction was the purpose of the colonies. Given the material resources and tech of the late 17Th C, the Brits would have found it difficult to hold on to colonies given the 13 colonies’ equivalent social and similar tech resources — esp when a rival power was willing to assist the insurgents.

Canada didn’t rebel in large part because of the infusion of loyalists from the US, plus their lenient treatment by the Brits (to prevent losing them as well).

None of this has any relevance to the ECRI report, which describes well-document global slowing in the developed nations — the others of which have far smaller defense budgets than the US. In large part this is due to a slowing of tech progress and aging populations. There is a massive body of research on this, which I’ve reported on during the past 10 years. I recommend reading Robert Gordon’s NBER papers for an intro.

“By some estimates, the war in Afghanistan has cost us nearly one trillion dollars … This amount alone …would have a significant impact on our capacity to feed the hungry and send children to college, to use your examples. ”

No, for two reasons. First, we could “feed the hungry and send children to college” in addition to our mad wars. Borrowing costs for the Federal govt are almost nothing, our debt levels are below those of our peers (most of whom are experiencing no ill effect from their debts).

Second, most of those costs from the war are increased liabilities — future pension and health care expenditures, plus interest cost on the funds borrowed. These are not actual expenditures — such as for feeding the hungry — and don’t show in the usual debt level calculations. What is your evidence that these increased liabilities — which few people even see — prevented increased spending on social services?

“First, we could “feed the hungry and send children to college” in addition to our mad wars.”

I didn’t say that we could not do these things while also carrying out our “mad” wars. My claim is that ending the war in Afghanistan would significantly increase our ability to feed the hungry and send children to college, especially given the fact that the war is ongoing. A significant increase in GDP would have more of an impact on social services, *if* our ability to manage increased production and allocation of resources is dramatically improved. There are countries with GDP per capita much lower than ours, for example, that provide affordable (if not free) higher education. Major policy changes that address our military as well as economic shortcomings would help us more than a fiscal policy that increases production while failing to address misallocation of resources, military or otherwise. Striving to increase production while prosecuting a fifteen-year long “mad” war is irrational.

“The greatest growth of the British Empire was in the 150 years after the Seven Years War. There is zero evidence that it was problematic for them in any long-term sense.”

But it was problematic for them in the 18th century. There is more than one author who makes this point, but Fred Anderson’s _Crucible of War_ states the case well:

“…the scope of Britain’s victory enlarged its American domains to a size that would have been difficult for any European metropolis to control, even under the best of circumstances, and the war created circumstances of the least favorable sort for Whitehall. Without the Seven
Years’ War, American independence would surely have been long delayed, and achieved (if at all) without a war for national liberation.” (xviii)

No, I simply meant that if my claim about the British Empire is absurd, as you stated, I’ll concede the point, for the reasons given above. Regardless, if I gave the impression of trying to deliberately confuse things, I apologize, that was not my intention.

All in all, I learned quite a bit from you during this discussion, and I appreciate the time you took to debate these issues. Thanks also for the reference to the NBER papers, I’ll give them a closer look.